Doing a "Short Sale"? New law gives you some tax relief

Both state department of revenues and the federal IRS generally claim immunity when it comes to kicking someone when they're down and out. And when you're forced into a short sale, about the last thing you need is tax repercussions... ala owning money on the amount you were short to pay off your mortgage balance. To the government's eyes, that's considered "income" and is taxable.

Or, to give you author Jim Wasserman's definition from his article, "Homefront: Check this mortgage worry off your list":

It's where the bank agrees to accept less than it's owed when a home sells. These sales, which enable banks to avoid the even costlier process of foreclosing and selling the house in a declining market, have become increasingly common this year. Under the standard short-sale scenario, if you sold your house this year for $350,000 but owed the bank $400,000, you'd have hefty tax consequences in 2008. The IRS would count that $50,000 in canceled debt as taxable income. It's what's known as "forgi en debt" and typically triggers a 1099 tax form. But now, the IRS is required -- for three years -- to abandon its traditional tax rules on canceled debts.

But as of Dec 20th, 2007, some of that has been eased. Those accepting losses on their primary residences due to short sales will no longer be responsible for a certain amount of the discharged debt... at least up to $2 mil.

The passage of the HR3649, aka know as the Mortgage Forgiveness Debt Relief Act of 2007 will enable the tax payer (or, more wisely, his/her accountant) to adjust the basis of the home's value by the amount of discharged indebtedness excluded from gross income - all within the new law's criteria.

What does not appear to be included in that forgiven debt is the amount spent for lender, title or realtor services.... or as the language in the bill summary as approved states:

Reduces the basis of a principal residence by the amount of discharged indebtedness excluded from gross income. Disallows an exclusion for a discharge of indebtedness on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer. Sets forth rules for determining the allowable amount of the exclusion for taxpayers with nonqualifying indebtedness and taxpayers who are insolvent.

Also, as this amends the federal Internal Revenue Code only, so this may not affect your state income returns. As usual with anything Congress writes - as you can see above - there are other vague or hidden "subject tos" that may affect your personal situation. So consult either your tax accountant, or tax attorney for the specifics.